Income recognition for various types of business. Most business firms recognize revenues at the time of sale or delivery of goods and services and, following the principles of the accrual basis of accounting, match expenses either with associated revenues or with the period when they consume resources in operations. Users of financial statements should maintain a questioning attitude as to the appropriateness of recognizing revenues at the time of sale and as to the timing of expense recognition. Exhibit 6.8 presents common-size income statements for seven firms for a recent year, with all amounts expressed as a percentage of total revenues. Exhibit 6.8 also indicates the revenues generated by each firm for each dollar of assets in use on average during the year. A brief description of the activities of each firm follows.

Amgen Amgen engages in the development, manufacturing, and marketing of biotechnology products. Developing and obtaining approval of biotechnology products takes 10 or more years. Amgen has two principal products that it manufactures and markets and several more products in the development pipeline.

Brown-Forman Brown-Forman is a distiller of hard liquors. After combining the ingredients, the company ages the liquors for five or more years before sale.

Deere Deere manufactures farm equipment. It sells this equipment to a network of independent distributors, who in turn sell the equipment to final consumers. Deere provides financing and insurance services both to its distributors and to final consumers.

Fluor Fluor engages in construction services on multiyear construction projects. It subcontracts most of the actual construction work and receives a fee for its services.

Golden West Golden West is a savings and loan company. It takes deposits from customers and lends funds, primarily to individuals for home mortgages. Customers typically pay a fee (called "points") at the time of loan origination based on the amount borrowed. Their monthly mortgage payments include interest on the outstanding loan balance and a partial repayment of the principal of the loan.

Merrill Lynch Merrill Lynch engages in the securities business. It obtains funds primarily from short-term capital market sources and invests the funds primarily in short-term, readily marketable financial instruments. It attempts to generate an excess of investment returns over the cost of the funds invested. Merrill Lynch also offers fee-based services, such as financial consulting, buying and selling securities for customers, securities underwriting, and investment management.

Rockwell Rockwell is a technology-based electronics and aerospace company. It engages in research and development on behalf of its customers, which include the U.S. government (space shuttle program, defense electronics) and private-sector entities. Its contracts tend to run for many years on a constantly renewed basis.

a. When should each of these companies recognize revenue? What unique issues does each company face in the recognition of expenses?

b. Suggest possible reasons for differences in the net income divided by revenues percentages for these companies.

Transcribed Image Text:

EXHIBIT 6.8 Common-Size Income Statements for Selectel Companies (Problem 37) Amgen Brown- Forman Deere Fluor Golden West Merrill Lynch Rockwell Revenues Sales of Goods Sales of Services Interest on Investments Total Revenues 98.7% 99.9% 83.6% 99.3% - 99.7% 2.0% 47.5% 1.3 0.1 16.4 0.3 98.0 52.5 0.7 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% Expenses Cost of Goods or Services Sold (14.3) (35.5) (69.4) (95.6) (43.3) (77.4) Selling and Administrative (23.4) (33.1) (11.4) (.6) (15.9) (12.6) Other Operating (26.4) (15.4) (3.5) (3.3) Interest (.7) (1.3) (11.0) (.2) (60.4) (47.2) (.9) Income before Income Taxes 35.2% 14.7% 4.7% 3.6% 20.4% 9.5% 9.1% Income Tax Expense (16.1) (5.9) (1.6) (1.3) (8.4) (3.9) (3.5) Net Income 19.1% 8.8% 3.1% 2.3% 12.0% 5.6% 5.6% Revenues/Average Total Assets 0.9 1.3 0.7 3.1 0.1 0.1 1.2 *Represents research and development costs for Amgen and Deere, excise axes for Brown-Forman, and a provision for loan losses by Golden West.