Risk Assessment




Risk Assessment

Accounting has never been black and white, nor will it ever be. One of the more subjective requirements concerns how collectable a particular sale might be.

To illustrate how chief financial officers and auditors might be second-guessing previous judgments, the Business Journal consulted with local accountants to create fictitious scenarios of how revenue could be recognized three ways all legitimate, each one more risky than the next.

The fictitious firm is ABC Co., a 25-year-old maker of microchips that are used by the software industry. The company has generated a steady revenue stream from its premier product, FastChip. In January 2002, ABC introduced what it believed to be a newer, better product: FasterChip. ABC planned to sell FasterChip to its old-line customers, but also to the growing number of start-ups that have sprouted along the 101 Technology Corridor.

For the first quarter ended March 31, ABC reported sales of $100 million. Of that, $50 million came from FastChip, the balance from FasterChip. Sales of FastChip were made to old, reliable customers, all of whom have a decades-long history of paying their bills on time. For that reason, ABC assumes that money will be collected. The auditor agrees.

Problems arise when the $50 million in FasterChip sales are considered.

The CFO is under pressure from Wall Street. Naysayers are passing ABC off as a technology firm gone stale. They say it hasn’t made a dime off anything but FastChip, and that was introduced in 1982. So the company really wants to book that additional $50 million.

The sales meet just about every standard set up by the regulatory bodies. ABC has a written proof of purchase for all the orders. But when considering the $50 million, ABC’s auditor is unsure about how collectable the sales are. He produces three separate scenarios of how the company should proceed:

Route A Super Conservative: Based on FasterChip being new, ABC’s auditors say it’s prudent to defer the entire $50 million until the second quarter. The product is untested in the marketplace and besides, many of ABC’s new customers are start-ups with a young credit history. But putting off the revenues would have an adverse effect on ABC’s stock, since Wall Street expects to see increased revenues from the new product launch.

Net Revenue: $50 million

Route B Middle Road: Since half of the $50 million in new sales consist of orders from big-name customers, ABC takes in $25 million of that in the first quarter; the rest to be deferred until collected. There is no reason to believe FasterChip would fail; in the past, most customers have paid their bills in a timely fashion.

Net Revenue: $75 million

Route C Aggressive: ABC has made the sales and therefore it should book the revenue. All customers take a while to pay; is there really a reason to consider a growing start-up to be less reliable than an established player? FasterChip is the next step for the software industry, and it’s become an industrywide practice to recognize all revenues up front.

Net Revenue: $100 million

Conor Dougherty

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