Midwestern Companies, a firm specializing in the production and sale of ethanol plants, used accrual accounting to report revenues from the sale of the plants. However, details of the sale of an ethanol plant have left many questioning Midwestern’s accounting practices. An investor in a partnership would pay $15,000 and sign a note for $45,000. After the initial investment, investors were not required to pay any more money as the cash from the operations of the plant would be applied against the note. Midwestern promised that the plant would operate properly and that those purchasing the plant would be provided with customers. While the firm reported $36.3 million in revenues from the sale of ethanol plants with costs of $12.2 million, it received only $10.8 million in cash. Thus, on a cash basis, the firm was actually operating at a loss for the period.
1. In selling an ethanol plant, identify the various points at which one could argue that the earnings process is substantially complete. At what point do you think Midwestern was recognizing revenue?
2. Did the use of accrual accounting accurately portray the financial performance of Midwestern?
3. In your opinion, what revenue recognition method should have been used by Midwestern?