Revenue Recognition and the Matching Principle Listum & Sellum Inc. is a medium-sized midwestern real estate company. It was founded five years ago by its two principal stockholders, Willie Listum and Dewey Sellum. Willie is president of the company, and Dewey is vice president of sales. Listum & Sellum has enjoyed tremendous growth since its inception by aggressively seeking out listings for residential real estate and paying a generous commission to the selling agent.

The company receives a 6% commission for selling a client’s property and gives two-thirds of this, or 4% of the selling price, to the selling agent. For example, if a house sells for $100,000, Listum & Sellum receives $6,000 and pays $4,000 of this to the selling agent. At the time of the sale, the company records a debit of $6,000 to Accounts Receivable and a credit of $6,000 to Sales Revenue. The accounts receivable is normally collected within 30 days. Also at the time of sale, the company debits $4,000 to Commissions Expense and credits Commissions Payable for the same amount. Sales agents are paid by the 15th of the month following the month of the sale. In addition to the commissions expense, Listum & Sellum’s other two major expenses are advertising of listings in local newspapers and depreciation of the company’s fleet of Cadillacs (Dewey believes that all of the sales agents should drive Cadillacs). The newspaper ads will run for one month, and the company has until the 10th of the following month to pay that month’s bill. The automobiles are depreciated over four years (Dewey doesn’t believe that any salesperson should drive a car that is more than four years old).

Due to a downturn in the economy in the Midwest, sales have been sluggish for the first 11 months of the current year, which ends on June 30. Willie is very disturbed by the slow sales this particular year because a large note payable to the local bank is due in July and the company plans to ask the bank to renew the note for another three years. Dewey seems less concerned by the unfortunate timing of the recession and has some suggestions as to how he and Willie can

“paint the rosiest possible picture for the banker” when they go for the loan extension in July. In fact, Dewey has some very specific recommendations for you as to how to account for transactions during June, the last month in the fiscal year.

You are the controller for Listum & Sellum and have been treated very well by Willie and Dewey since joining the company two years ago. In fact, Dewey insists that you drive the top-of-the-line Cadillac. Following are his suggestions:

First, for any sales made in June, we can record the 6% commission revenue immediately but delay recording the 4% commission expense until July, when the sales agent is paid. We record the sales at the same time we always have, the sales agents get paid when they always have, the bank sees how profitable we have been, we get our loan, and everybody is happy!

Second, since we won’t be paying our advertising bills for the month of June until July 10, we can wait until then to record the expense. The timing seems perfect since we are meeting with the bank for the loan extension on July 8.
Third, since we will be depreciating the fleet of “Caddys” for the year ending June 30, how about changing the estimated useful life on them to eight years instead of four years?
We won’t say anything to the sales agents; no need to rile them up about having to drive their cars for eight years. Anyhow, the change to eight years would just be for accounting purposes. In fact, we could even switch back to four years for accounting purposes next year. Likewise, the changes in recognizing commission expense and advertising expense don’t need to be permanent either; these are just slight bookkeeping changes to help us get over the hump!
Required 1. Explain why each of the three proposed changes in accounting will result in an increase in net income for the year ending June 30.
2. Identify any concerns you have with each of the three proposed changes in accounting from the perspective of GAAP. If these changes are made, do the financial statements faithfully represent what they claim to represent? Are these changes merely bookkeeping changes? Explain your answer.
3. From an ethical perspective, identify any concerns you have with each of the three proposed changes in accounting. Do the proposed changes provide information that is free from bias?
Explain your answer.
4. Does the controller benefit by making the proposed changes? Are outsiders harmed?
Explain your answer.