July 22, 2013
Excello Telecommunications Disappointing Earnings
Excello telecommunications is a company that has been profitable for many years, but quarter four in 2010 is proving to be the first time in the history of the company when earnings estimates will not be met, particularly due to increased competition by overseas manufacturers (Mintz & Morris, 2011). Not meeting earnings estimates will be a disappointment to company executives, investors and Wall Street analysts. Terry Reed, the CFO of Excello Telecommunications, has learned that the future sale of $1.2 million in equipment to Data Equipment Systems could help Excello Telecommunications earnings if the sale could be moved up to the current quarter, rather than on January 11th, 2011 (Mintz & Morris, 2011). Getting the sale completed in December allows earnings estimates to be met for the current quarter, thus giving Excello Telecommunications another profitable quarter.
Terry Reed wants the sale completed in December and approaches Excello’s controller, Marty Fuller and impresses upon Mr. Fuller the need to get the sale booked in 2010 (Mintz & Morris, 2011). Data Equipment Systems does not have warehouse space available until January 11th, 2011, so they do not want the equipment shipped until shortly before the 11th. Because Excello’s for quarter four of 2010 are below expectations, this large sale of $1.2 million presents a tempting earnings issue for Excello Telecommunications, and particularly Terry Reed. Mr. Reed meets with Marty Fuller, Excello’s controller, and discusses the need to record the $1.2 million sale in 2010 and also explains that the customer cannot accept the shipment until January 11th. Mr. Reed tasks Mr. Fuller with finding a creative way around the accounting rules so that the $1.2 million sale can be will be recorded in 2010 (Mintz & Morris, 2011).
Marty Fuller meets with his accounting team to discuss how the $1.2 million sale can be recognized in 2010 while also advising the team that however the sale is recorded, the sale must be defensible from a GAAP (Generally Accepted Accounting Principles) point of view (Mintz & Morris, 2011). The accounting team put their minds to work and came up with three options.
The Excello Telecommunications accounting team’s first option is to record the $1.2 million sale in December, 2010, transfer the product to an off-site Excello owned warehouse by December 31st and hold it until January 11th, 2011, when it would be shipped to Data Equipment Systems (Mintz & Morris, 2011). This conflicts with all ethical and legal accounting standards, as Excello would be recognizing the revenue in one accounting period yet the sale would not be recorded until a future accounting period. This goes against GAAP, as the sale and shipment must be recorded in the same period. This option also conflicts with the Sarbanes-Oxley Act of 2002 (SOX), as the law requires that the company’s financial statements do not contain any untrue statements of a material fact (Mintz & Morris, 2011). While recording revenue earned in one period yet knowing that the shipment will take place in a future period, reporting financials under this guise would be misleading to investors, analysts and regulators (Mintz & Morris, 2011). This option would be masking the true operating results of Excello Telecommunications and would not be defensible from a GAAP point of view.
The accounting team’s second option is to transfer the equipment to Data Equipment Systems by December 31st, 2010, and agree that the customer could return the product for a full refund after it arrives at Data Equipment Systems’ warehouse (Mintz & Morris, 2011). Under this option, the sale and shipment would be recorded within the same period, so GAAP and SOX rules would be satisfied with the sale and shipment, yet the underlying principal of this action