III. Delivery and Performance

1. III. Delivery and Performance Presented by: Tammy Li, AjithSedevan, Alex Wang and Susan Woo (Group III)

2. Scenario • Company A received an order for its products at the end of its fiscal quarter. • If the Customer is not ready to receive the goods that could be due to one of the reasons below: • Does not have available space for storage. • Has more than sufficient inventory. • Delays in customer’s product schedule.

3. Question • Should Company A recognize revenue if company A: • Segregates the inventory of the products in it own warehouse from its own products? • Ships the products to a third-party warehouse (Company A retains title of the products and payment by customer is dependent upon ultimate delivery to the customer’s designated site)?

4. Answers • Sales Type: Bill & Hold. • Company A should NOT recognize revenue because: • Title has yet to be passed to buyer. • Risks and rewards have yet to be assumed by buyer.

5. Criteria for Bill and Hold • The risks of ownership must have passed to buyer; • The customer must have a fixed commitment (documented) to purchase the goods; • The BUYER must request that the transaction be on a bill and hold basis and the buyer must have substantial business purpose for such request; • The delivery schedule must be determined and the date(s) must be reasonable and must be consistent with the buyer’s business purpose; • The seller must not have retained any specific performance obligations that will delay the earning process; • The ordered goods must have been segregated from the seller’s inventory and cannot be used to fill other orders; and • The goods must be complete and ready to ship.

6. Exercise Problem • On 03/01/2014, Satem Inc., a manufacturing company, received a $5,000 purchase order for its products from Future Tech Corporation. • On 04/01/2014, the products was complete and ready for shipment. • Satem Inc.’s costs for manufacturing the goods were $2,000. • Future Tech was not ready to receive the goods from SatemInc. • Satem Inc. shipped the goods to a third-party warehouse. • On 06/01/2014, the goods was shipped to Future Tech’s designated warehouse.

7. Exercise Questions and Answers • Should there be any journal entry on March 01, 2014? • No, since the goods were yet shipped to the customer, title, risks and rewards were yet transfered to the customer. Samtec couldn’t recognized revenue, thus no journal entry. • Should there be any journal entry on April 01, 2014? • Yes, there should three sets of journal entries, two entries for converted work-in-process into finish products, two entries for the finished goods shipped to third-party warehouse, and two entries for the shipping cost. • Should there be any journal entry on June 01, 2014? • Yes, Samtec could recognized revenue after the goods had shipped to the customer.

8. Journal Entries

9. Real World Case: United States Security and Exchange Commission v. Nortel Network Corporation • Nortel Network Corporation, a Canadian communication company, was suited by SEC for engaged in fraudulent accounting schemes. • Nortel inflated its revenues by introduced “bill and hold” into it revenue recognition accounting practices in 2000, 2002 and 2003. • Nortel recognized revenues on undelivered goods that were sitting in its warehouses and offsite storage locations. • The “bill and hold” transactions weren’t requested by Nortel’s customers and the practices did not applied to Nortel’s customers’ business purposes.

10. The Reasons for SEC Take Action Against Nortel • The SAB 101 has several guidelines in order for the revenues to be considered earned, realized and realizable. • The Nortel “Bill and hold” scheme violated the SAB 101 guidelines no. 3. • The SAB guidelines no. 3 statesthat the buyer, not the seller, must request that the transaction be on a bill and hold basis. The buyer must have a substantial business purpose for ordering the goods on a bill and hold basis. • The SEC alleged Nortel did not meet those guidelines for “bill and hold” accounting practice. • Nortel later agreed to paid $35 million in fine and $2.45 billion for class action settlement.