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ACCT7102- Financial Accounting For Canadian Pharmaceutical Firm

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  • Course Code: ACCT7102
  • University: The University Of Queensland
  • Country: Australia

Questions

Question One

(a) The following table provides a summary of the revenue recognition that would occur if the company Biovail implemented (i) ‘free on board’ (FOB) Biovail; or (ii) FOB
destination.
 
(b) There was dissention between the Distributor and Biovail over when title to the shipment of WellbutrinR passed. Discuss why you think the disagreement occurred between Biovail and the Distributor. Your answer should be supported by reference to at least three academic research articles. (Hint: Concentrate on the general results of
the articles. You do not have to completely understand the econometric models if used in articles.)

Question Two

Following the truck accident, analysts from J.P. Morgan upheld their ‘overweight’ stock rating for Biovail. In fact, representatives from J.P. Morgan noted that (case study, p. 3): ‘…its analysts had never argued with earlier claims that Biovail’s accounting might have been aggressive. However, its analyst report concluded that Biovail’s current accounting did not seem egregious and that the earnings impact of Wellbutrin XL was completely transparent.’
 
Evaluate these comments from J.P. Morgan. (Hint: Your answer should evaluate earnings quality (i.e. aggressive accounting choices compared with egregious accounting choices) and be supported by reference to at least two academic research articles. Concentrate on the general results of the articles. You do not have to completely understand the econometric models)

Question Three 

Assume that Biovail plans to undertake a significant share issue in the near future and is considering either J.P. Morgan or Banc of America to handle this lucrative transaction.
 
Would you expect this to influence Mr Maris’ analysis of the truck accident and subsequent stock recommendation? Justify your opinion discussing any ethical issues that may arise.

 

Answer:

Introduction 

The company Biovail Corporation is a Canadian Pharmaceutical Firm, which is publicly listed, and it has been operating since many years. Its expertise is to apply advanced drug delivery technologies and the improve the effectiveness of the medicines. It is involved in development and manufacturing of the various pharmaceutical products. It has commercialised the product in Canada as well as internationally through strategic partners (Bailey, Collins, & Abbott, 2017). The company also distributes its products in United States but one of its recent in-transit shipments which it claims to be carrying a huge inventory ranging between $10-$20 Mn has met with an accident and it is going to have a serious impact on the overall revenue as well as earnings per share estimates for quarter ended 20th September 2003. 

Question 1: Revenue Recognition, Managerial Motivation and Research Component

  1. For the revenue to be recognised in the books of accounts of the company, the following conditions should be met:
  2. There should be a persuasive evidence that the arrangement exists between the parties
  3. The delivery of the goods and services in question must be completed
  • The associated risk and reward with respect to the ownership in the goods have also been transferred to the buyer(Dichev, 2017)
  1. The price at which the seller sells to the buyer is determinable or fixed
  2. There is a certainty in the collection and it can be reasonably assured. 

For the given 6 cases of revenue recognition, the following is the justification of the case if the company Biovail implemented Free on board Biovail or Free on Board destination.

Type

Particulars

Description

Remarks

FOB Biovail

Ownership transfers:

Upon shipment from
Biovail facility in
Manitoba, Canada

In case FOB Biovail is selected as incoterms, then the risk and reward to the buyer would pass at Manitoba, Canada and therefore the revenue can be recognised if collection certainty is there.

Revenue is earned:

Upon shipment from
Biovail

No, for the recognition of revenue, further conditions needs to be satisfied like the amount should be fixed and the collectability of the same should be certain, only then can be revenue be recognised in the books.

Assuming that there
was no accident, the
associated revenue
would be earned:

30 September when the
truck left Biovail’s facility
in Manitoba

Yes, in case there was no accident and the significant risks and rewards would have been transferred on delivery and the amount was certain then the revenue could have been earned and realised in books on 30th September itself (Dumay & Baard, 2017).

FOB Destination

Ownership transfers:

Upon delivery to North
Carolina facility of Distributor

In case FOB Destination is selected as incoterms, then the risk and reward to the buyer would pass at North Caroline (at the distributor’s facility) and therefore the revenue can be recognised once it reaches there only and collection is certain.

Revenue is earned:

Upon delivery to North
Carolina facility of Distributor

No, just on delivery the revenue cannot be earned in books. For the recognition of revenue, further conditions needs to be satisfied like the amount should be fixed and the collectability of the same should be certain, only then can be revenue be recognised in the books (Linden & Freeman, 2017).

Assuming that there
was no accident, the
associated revenue
would be earned:

Either very late on 1 October,
or more likely 2 October given
that North Carolina is more
than 8 hours’ drive away

Yes, in case there was no accident and the significant risks and rewards would have been transferred on delivery  and the amount was certain then the revenue could have been earned and realised in books on 1st or 2nd October as soon as it reaches to North Caroline. But then this would not qualify as avenue for period ended 30th September 2003.

  1. There was a disagreement between the distributor and the company Biovail over the timing of transfer of title of the shipment of Wellbutrin, which was transported. It is due to this reason that the employee of the distributor directly called the Vice President of Finance, Biovail, Mr. Kenneth Howling to correct the statement on revenue recognition given by CEO of BIovail, Mr. Brain Crombie in the conference call in Earnings guidance and informed that as per the agreement between Biovail and the Distributor, the title, risk and reward with respect to the goods delivered would pass on to the distributor once it reaches the Distributor’s Facility (FOB destination). Whereas the CEO of the company assumed that, the terms of delivery were FOB Biovail and title on the goods would change in Manitoba at shipping point. This was the main reason of disagreement as in case of FOB destination the company would have borne the loss, if any during the transit of the goods and the insurance and transit charges would have been borne by Biovail depending on the terms of the contract but in case the incoterms is FOB shipping point, then the risk of transit loss post Manitoba would be on distributor(Du, 2018). As the academic article, “An experimental investigation of dimensional precision in uncertainty disclosures related to revenue recognition”, it all depend on the terms of the contract between the parties as to when the revenue should be recognised in the books and the same should be clearly specified in the disclosures and studied at the time of revenue recognition. One another research article is “An examination of SEC revenue recognition comments and IPO earnings management”, which explains on how the revenue and the earning per share as well as the share prices of the company gets impacted through revenue recognition criteria’s (Schuldt, 2018). The last academic research article that has been referred to as “ASC 606: Challenges in understanding and applying revenue recognition”, which explains what are different criteria’s to be observed while revenue recognition and what are the general challenges in this case (Hepp, 2018).
 

Question 2: Earnings Quality and Research Component

In the given case, the analysts from J.P. Morgan Securities Inc. was upbeat and mentioned that the rating of Biovail was “overweight” on the truck accident incident and reiterated that they have never argued that the accounting policies of the company was aggressive instead it claimed that the company’s current accounting policies were not overtly egregious and that the earnings impact of the Wellbutrin XL was truly shown and disclosed by the company. The comment was given in line of the poor earnings performance of the company over the past periods and continuous downgrading of the earning guidance. The analysts has shown though the company had been using good and correct accounting policies, but it was inflating its income and showing the same aspirationally to the investors in order to attract them and later on restating the same downwards. It was also enquired and studied as to how much of the truck would need to be filled in order to prove the missing revenue claim by Biovail due to truck accident and it was established that the truck was only one quarter full instead of the nearly full truck which suggested that the company has overestimated the loss and thus deceiving the investors (Van Rinsum, 2018). It had a serious impact on the third quarter revenues of the company and thus it can be said that Treppel’s remarks on aggressive accounting techniques being used by Biovail was completely true and justified. As per the MD&A disclosure which is required by Financial Reporting Release 36, a company should be disclosing both the historical as well as prospective trend of financial condition and that would help the investor in understanding the results of the operation and factors which are contributing to increase or decrease in revenue. Many companies have resorted to techniques like channel stuffing which means artificially inflating the revenue by deliberately sending more goods to the retailers and these results in bringing down the sales for the future period. All this has also been stated in the research journal articles “Disclosure Checklists and Auditors’ Judgments of Aggressive Accounting” and “The Modern Corporation and the Public Interest” (Bogle, 2018). Both the articles suggest that the accounting needs to comply with the standards and requisite disclosures should be made in this regard to meet the users’ need of correct information.

Question 3: Ethical Component

In the given case, if Biovail plans to issue the shares in the future and if the company considers Banc of America or J.P. Morgan to handle and coordinate for this lucrative transaction, then it would certainly influence Mr. Maris’ analysis of the company and its accounting techniques and the findings on the truck accident and thereby the stock recommendation. This is because Biovail is the account, which is in the hands of Mr. Maris, the successor of Jerry Treppel and the company has already had a more than 20% decline in the value of the shares (Fay & Negangard, 2017). Mr. Treppel was placed on leave during 2002 by BAS when he had issued a true report on the Biovail and had issued a sell recommendation based on his studies that the revenue and the earning quality of the company has not been of highest quality in the past few years and that the company’s growth in the sales was not sustainable considering the over reliance on one of the product sales named Cardizem which accounted for 40% of the revenue. It is because of the this true analysis and sell recommendation given by him that the investigation on him by New York State Attorney General’s Office and the Securities Exchange Commission and the National Association of Securities Dealer and ultimately he had to resign from the position. If Maris would have done the same, he also might have landed in the same circumstance and above all if Maris would give true report, it would have affected revenue and earnings of BAS and JP Morgan, whatsoever may be the case (Kachelmeier, Schmidt, & Valentine, 2018). This is an ethical issue as per APES 110, which states that the true and fair view of affairs should be reflected to the investors for correct decision-making or else the decision would be biased.

Conclusion

From the above discussion and analysis, we see that the unfavourable variance has caused a huge fluctuation in the share prices and though the company had insurance for the goods lost in transit but it was still facing losses in quarterly revenue. The analysts from Banc of America and J.P.Morgan has cut down on the rating of the company and have instigated an investigation into the issue following the continuous decrease in the performance of the company. All the given questions have been answered based on the circumstances of the case.

 

References 

Alexander, F. (2016). The Changing Face of Accountability. The Journal of Higher Education, 71(4), 411-431.

Bailey, C., Collins, D., & Abbott, L. (2017). The Impact of Enterprise Risk Management on the Audit Process: Evidence from Audit Fees and Audit Delay. Auditing: A Journal of Practice & Theory, 37(3), 25-46.

Bogle, J. C. (2018). The Modern Corporation and the Public Interest. Financial Analysts Journal, 74(3), 1-10.

Dichev, I. (2017). On the conceptual foundations of financial reporting. Accounting and Business Research, 47(6), 617-632. doi:https://doi.org/10.1080/00014788.2017.1299620

Du, N. &. (2018). An experimental investigation of dimensional precision in uncertainty disclosures related to revenue recognition. Accounting Research Journal, 31(1), 90-101.

Dumay, J., & Baard, V. (2017). An introduction to interventionist research in accounting. The Routledge Companion to Qualitative Accounting Research Methods, 265. Retrieved from https://books.google.co.in/books?hl=en&lr=&id=PzQlDwAAQBAJ&oi=fnd&pg=PA265&dq=Dumay,+J.,+%26+Baard,+V.+(2017).+An+introduction+to+interventionist+research+in+accounting.+The+Routledge+Companion+to+Qualitative+Accounting+Research+Methods,+265.&ots=ta1isTHB

Fay, R., & Negangard, E. (2017). Manual journal entry testing : Data analytics and the risk of fraud. Journal of Accounting Education, 38, 37-49.

Hepp, J. (2018). ASC 606: Challenges in understanding and applying revenue recognition. Journal of Accounting Education, 42(1), 49-51.

Kachelmeier, S., Schmidt, J., & Valentine, K. (2018). The disclaimer effect of disclosing critical audit matters in the auditor’s report. SSRN, 2(1), 1-39.

Linden, B., & Freeman, R. (2017). Profit and Other Values: Thick Evaluation in Decision Making. Business Ethics Quarterly, 27(3), 353-379. Retrieved from https://doi.org/10.1017/beq.2017.1

Schuldt, M. &. (2018). An examination of SEC revenue recognition comments and IPO earnings management. Accounting Research Journal, 1-15.

Van Rinsum, M. M. (2018). Disclosure Checklists and Auditors’ Judgments of Aggressive Accounting. European Accounting Review, 27(2), 383-399.

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