Case 1.4 Sunbeam: The Revenue Recognition Principle Synopsis In April 1996 Sunbeam named Albert). Dunlap as its CEO and Chairman, Formerly with Scott Paper Co., Dunlap was known as a tumaround specialist and was even nicknamed "Chainsaw Al" because of the cost-cutting meas ures he typically employed. Almost immediately, Dunlap began replacing nearly all of the upper management team and led the company into an aggressive corporate restructuring that included the elimination of half of its 12,000 employees and the elimination of 87 percent of Sunbeam's products. Unfortunately, in May 1998 Sunbeam disappointed Investors with its announcement that it had earned a worse-than-expected loss of 544.6 mil- lion in the first quarter of 1998. Dunlap was fired in June 1998. In October 1998 Sunbeam announced that it would need to restate its financial state ments for 1996, 1997, and 1998.2 Sunbeam's Customer Discounts and Other Incentives and Sales to Distributors Under GAAP, sales revenue can be recognized only if the buyer assumes the risks and rewards of ownership of merchandise--for example, the risk of dam- age or physical loss. A sale with a right of return can be recognized as revenue only if the seller takes a reserve against possible future returns. The size of this reserve must be based on the company's history with returns; the sales revenue may not be recorded if no such history exists. Beginning with the first quarter of 1997, Sunbeam began offering its cus tomers discounts and other incentives if they placed their orders in the current Robert Frank and Joann S. Lublin. "Dunlap's Ax Falls 6,000 Times at Sunbeam." The Wall Street Journal, November 13, 1996, p. 31 GAO-03-138, Appendix XVII, "Sunbeam Corporation,"p. 201 18 Section One Freud Case: Vilations of Accounting Principles period rather than holding off until the next period. Sunbeam did not disclose its practice of accelerating expected sales from later periods in its financial statements, however. In the other quarters of 1997, Sunbeam also allegedly relied on additional price discounting and other incentives in an attempt to accelerate recognition of revenue from future periods. One example of a special arrangement with a customer took place at the end of March 1997, just before the first quarter closed. Sunbeam recognized $1.5 million in revenue and contributed $400.000 toward net income from the sale of barbecue grills to a wholesaler. The contract with the wholesaler provided that the wholesaler could return all of the merchandise, with Sunbeam paying all costs of shipment and storage, if it was unable to sell it. In fact, the wholesaler wound up returning all of the grills to Sunbeam during the third quarter of 1997, and the wholesaler incurred no expenses in the transaction." Sales to Distributors In December 1997 Sunbeam devised a "distributor program that would help improve the company's sales. The program was designed to help Sunbeam accel- erate the recognition of sales revenue for merchandise it placed with distributors in advance of actual retail demand. Sunbeam allegedly used favorable payment terms, discounts, guaranteed markups, and, consistently, the right to return unsold product as incentives for distributors to participate in the program The sales under the distributor program represented a new distribution channel for the company. Therefore Sunbeam was unable to set an appropriate level of reserves for any returns. Bill and Hold Sales In the second quarter of 1997 Sunbeam recognized $14 million in sales rev. enue from bill and hold sales. By the fourth quarter Sunbeam had recognized $29 million in revenues and contributed an additional $1.5 million toward net income in bill and hold sales after it began promoting its bill and hold pro gram. In all, bill and hold sales contributed to 10 percent of the fourth quar- ter's revenue. At year-end 1997, Sunbeam disclosed in its annual filing to the SEC that "the amount of the bill and hold sales at December 29, 1997, was approximately 3 percent of consolidated revenues." It did not disclose the extent to which the bill and hold sales had been booked in the final quarter SEC Accounting and Auditing Enforcement Release No. 1393, May 15, 2001, * SEC Accounting and Auditing Enforcement Release No. 1393, May 15, 2001, SSEC Accounting and Auditing Enforcement Release No. 1706, January 27, 2003. SEC Accounting and Auditing Enforcement Release No. 1394, May 15, 2001, SEC Accounting and Auditing Enforcement Release No. 1394, May 15, 2001, 1. Identify SAS No. 99 risk factors implicated by the case. 2. Define the key principle or concept identified in the title. (e.g., what is the revenue recognition principle? What is the definition of "asset?" What is the expense recognition principle?) 3. Discuss the core accounting issues associated with the principle or concept. Case 1.4 Sunbeam: The Revenue Recognition Principle Synopsis In April 1996 Sunbeam named Albert). Dunlap as its CEO and Chairman, Formerly with Scott Paper Co., Dunlap was known as a tumaround specialist and was even nicknamed "Chainsaw Al" because of the cost-cutting meas ures he typically employed. Almost immediately, Dunlap began replacing nearly all of the upper management team and led the company into an aggressive corporate restructuring that included the elimination of half of its 12,000 employees and the elimination of 87 percent of Sunbeam's products. Unfortunately, in May 1998 Sunbeam disappointed Investors with its announcement that it had earned a worse-than-expected loss of 544.6 mil- lion in the first quarter of 1998. Dunlap was fired in June 1998. In October 1998 Sunbeam announced that it would need to restate its financial state ments for 1996, 1997, and 1998.2 Sunbeam's Customer Discounts and Other Incentives and Sales to Distributors Under GAAP, sales revenue can be recognized only if the buyer assumes the risks and rewards of ownership of merchandise--for example, the risk of dam- age or physical loss. A sale with a right of return can be recognized as revenue only if the seller takes a reserve against possible future returns. The size of this reserve must be based on the company's history with returns; the sales revenue may not be recorded if no such history exists. Beginning with the first quarter of 1997, Sunbeam began offering its cus tomers discounts and other incentives if they placed their orders in the current Robert Frank and Joann S. Lublin. "Dunlap's Ax Falls 6,000 Times at Sunbeam." The Wall Street Journal, November 13, 1996, p. 31 GAO-03-138, Appendix XVII, "Sunbeam Corporation,"p. 201 18 Section One Freud Case: Vilations of Accounting Principles period rather than holding off until the next period. Sunbeam did not disclose its practice of accelerating expected sales from later periods in its financial statements, however. In the other quarters of 1997, Sunbeam also allegedly relied on additional price discounting and other incentives in an attempt to accelerate recognition of revenue from future periods. One example of a special arrangement with a customer took place at the end of March 1997, just before the first quarter closed. Sunbeam recognized $1.5 million in revenue and contributed $400.000 toward net income from the sale of barbecue grills to a wholesaler. The contract with the wholesaler provided that the wholesaler could return all of the merchandise, with Sunbeam paying all costs of shipment and storage, if it was unable to sell it. In fact, the wholesaler wound up returning all of the grills to Sunbeam during the third quarter of 1997, and the wholesaler incurred no expenses in the transaction." Sales to Distributors In December 1997 Sunbeam devised a "distributor program that would help improve the company's sales. The program was designed to help Sunbeam accel- erate the recognition of sales revenue for merchandise it placed with distributors in advance of actual retail demand. Sunbeam allegedly used favorable payment terms, discounts, guaranteed markups, and, consistently, the right to return unsold product as incentives for distributors to participate in the program The sales under the distributor program represented a new distribution channel for the company. Therefore Sunbeam was unable to set an appropriate level of reserves for any returns. Bill and Hold Sales In the second quarter of 1997 Sunbeam recognized $14 million in sales rev. enue from bill and hold sales. By the fourth quarter Sunbeam had recognized $29 million in revenues and contributed an additional $1.5 million toward net income in bill and hold sales after it began promoting its bill and hold pro gram. In all, bill and hold sales contributed to 10 percent of the fourth quar- ter's revenue. At year-end 1997, Sunbeam disclosed in its annual filing to the SEC that "the amount of the bill and hold sales at December 29, 1997, was approximately 3 percent of consolidated revenues." It did not disclose the extent to which the bill and hold sales had been booked in the final quarter SEC Accounting and Auditing Enforcement Release No. 1393, May 15, 2001, * SEC Accounting and Auditing Enforcement Release No. 1393, May 15, 2001, SSEC Accounting and Auditing Enforcement Release No. 1706, January 27, 2003. SEC Accounting and Auditing Enforcement Release No. 1394, May 15, 2001, SEC Accounting and Auditing Enforcement Release No. 1394, May 15, 2001, 1. Identify SAS No. 99 risk factors implicated by the case. 2. Define the key principle or concept identified in the title. (e.g., what is the revenue recognition principle? What is the definition of "asset?" What is the expense recognition principle?) 3. Discuss the core accounting issues associated with the principle or concept