Real World Case 5-1
A bill and hold strategy accelerates the recognition of revenue. In this case, sales that would normally have occurred in 1998 were recorded in 1997. Assuming a positive gross profit on these sales, earnings in 1997 is inflated.
A customer would probably not be expected to pay for goods purchased using this bill and hold strategy until the goods were actually received. Receivables would therefore increase.
Sales that would normally have been recorded in 1998 were recorded in 1997. This bill and hold strategy shifted sales revenue and therefore earnings from 1998 to 1997.
Earnings quality refers to the ability of reported earnings (income) to …show more content…
If, however, a large percentage of customers do exercise the option, and the distortion in gross profit is material, the company should adopt a revenue recognition policy that results in a more stable gross profit percentage for the two transactions. Communication Case 5-5
The critical question that student groups should address is how to match revenues and expenses. There is no right or wrong answer. The process of developing the proposed solutions will likely be more beneficial than the solutions themselves. Students should benefit from participating in the process, interacting first with other group members, then with the class as a whole.
Solutions could take one of two directions:
1. Deferral of revenue recognition. As each ice cream cone is sold, a portion of the sales price is deferred and a liability is recorded. This liability will then be reduced and revenue recognized when the free ice cream cone is awarded.
2. The accrual of estimated cost. This direction views the free ice cream cone as a promotional expense. The estimated cost of the free cone should be expensed as the ten